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Morning Update

Since the beginning of 2013 the VIX has fallen over 30% and is now at lows not seen since 2007. But one trader believes that this could soon change: yesterday someone bought 100,000 VIX Feb. 16 calls for $0.55. This is a $5.5 million bet that the VIX will settle above 16.55 (30% higher) 13 trading days from now. The trade occurred just before the VIX spiked from about 12.60 to a high of 13.50 before reversing again to close at 12.75.

The VIX is a mean reverting product and this is a bet that it will revert off of its current exceptionally low level back towards its long term average, which is roughly the 15-20 range. However, there is no guarantee that the VIX will move back to these levels anytime soon. For instance, during 2005 and 2006 the VIX rarely popped above 15, preferring to stay between 10 and 15 since the market was bullish and realized volatility was low. During the financial crisis the VIX took off and has since spent much of its time above 20. As the ramifications of the US financial crisis fade and European debt crisis is resolved the VIX could move into its pre-crisis range of 10-15.

This trade was likely put on as a portfolio hedge instead of as a pure speculation on the VIX however. As a portfolio hedge it has lots of attractive qualities. First, the VIX typically moves up 4% for e very 1% down move in the S&P 500. When the VIX is at current low levels however it can become even more volatile. For instance yesterday the S&P 500 was down 0.20% and the VIX was up over 5%. Another reason it is an attractive hedge is that the implied volatility in VIX options is near all-time lows. If the VIX spikes the VVIX will spike too as traders rush to buy VIX calls as portfolio protection. A long VIX call will profit from both a rise in the VIX and an increase in VIX implied volatility, giving this hedge a good bang for your buck.

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